Cost benefit analysis

The most widely-used method for choosing between alternative investments designed to achieve some socially desirable outcome is cost-benefit analysis. This method has been widely used for assessing hazard mitigation projects in floods and other hazards, particularly major engineering projects.²⁶ At its simplest, the idea is that all the benefits of the project are computed in financial terms, the costs are then deducted, and the difference is the value of the project. All projects with a positive value are worthwhile, but in a situation with a number of possible alternative projects and with limited resources available for investment, the project or projects with the highest value, or alternatively the highest rate of return on initial investment, are chosen.

In most cases this simple idea is complicated by the fact that the investments are made some time in advance of the benefits being felt, so that some rate of trade-off between present cost and future benefit has to be introduced. This is generally dealt with by introducing a social discount rate, which is considered to reflect society's preference for present benefits over future benefits, and for which a consistent value is used in all project evaluations. All future costs and benefits are discounted by the use of this rate.

This method can be used in comparing alternative strategies to protect against hazards if, for example the cost is taken as the additional project cost solely related to providing hazard resistance, while the benefits are the reduction in future losses, in terms of building damage, loss of life and other incidental losses, which result from the improved resistance.

This simple theoretical formulation of the approach, does, however present considerable difficulties in application. The most important of these are the very large uncertainties about the probable levels of future losses, the fact that those who benefit and those who pay are often not the same people, and, even more serious, the theoretical and moral problems associated with putting a financial valuation to the loss or saving of human life.

Estimation of protection costs and future benefits

The calculation of the additional cost of a particular protection strategy is generally straightforward. If the alternative strategies being considered are alternative sets of strength requirements for facilities for example, it is a simple matter to carry out designs according to alternative sets of requirements, and calculate the cost difference based on current construction costs. The costs of other types of mitigation projects can similarly be evaluated through standard project costing techniques.

Benefits from the protection strategies accrue from savings in losses that would otherwise have occurred, i.e. the difference between the damage that would occur if the strategy was not implemented and the damage that would occur if it was implemented. Estimation of future losses for the range of hazard occurrences likely during the project lifetime may be made by the risk assessment method outlined above. Since neither the severity nor the occurrence time of future hazards can be predicted, these future loss calculations need to be done on a probabilistic basis. The range of possible severities is divided into discrete intervals; the annual probability of occurrence of a hazard within each interval is determined; and the probable damage distribution for each element at risk as a result of the hazard at each level of severity is assessed. Only those losses associated with the particular elements to be affected by the alternative strategies need to be computed, as any other losses will be unaffected. The cost of the tangible losses are summed up without the protection strategy, then the calculation is repeated to assess the lower levels of losses resulting from implementing the protection strategy. The savings in losses are the benefits.

Table 6
PROJECTED LOSSES DUE TO NATURAL HAZARDS (GEOLOGICAL) 1970-2000 AND COSTS OF MITIGATION, CALIFORNIA USA²⁷

a) applying all feasible methods
b) applying all feasible methods at current state of the art

Table 6 shows for example, the expected losses from a range of geological hazards in the state of California during a particular 30-year period. The reduction in losses from the application of 'all feasible measures' has also been calculated, and so has the cost of applying these measures. From such a table (though difficult to compile), the costs and the benefits of different mitigation schemes can be easily seen.

Costing saved lives

The most important aspect of many disaster mitigation strategies is likely to be that they will save lives. Evaluating which programs will save most lives is therefore an important output for risk assessment. Some analysts extend the technique of cost-benefit analysis to include the saving of life in its calculation. This is difficult for most people to come to terms with as it involves equating a human life with a financial value, which appears both illogical and morally questionable.

Where life-saving is to be evaluated in financial terms, the most widely used method of evaluating human life loss is the human capital approach, in which a life is valued in accordance with its potential for future productivity. At its simplest, the monetary value of an individual's life is the discounted sum of all of his or her expected future earnings. The advantage of this approach is that it is relatively simple to calculate. The method has been used in quantifying the benefits of life-saving programs, for instance the mandatory use of seat belts in automobiles. But distinguishing between the value of different individuals lives on the basis of their earning power is liable to lead to quite unacceptable decisions; for example, it could be computed that there was a zero or even negative loss in the collapse of an old people's home.²⁸ Similarly the lives of people living on low incomes would be given a lower value. Thus alternative means of appraising options are preferred.